Taxes on marijuana may force a showdown between state and federal laws

Voters at a Palo Alto polling place weigh in on Prop. 19. (Photo: Christina Farr)

It’s funny how elections work sometimes. On the day Californians defeated Proposition 19, voters in 10 cities authorized taxing marijuana.

Because Prop. 19 would have legalized the recreational use of pot, these new taxes will fall entirely on medicinal marijuana dispensaries in San Jose, Berkeley, Oakland, Sacramento, Stockton and the other five cities. But collecting the taxes might not be as easy as voters think.

Under U.S. law, marijuana is illegal, so to pay a tax for selling it, dispensaries must formally admit to a city that they are committing a federal crime.

Dispensaries already operate in a gray area: medicinal marijuana has been legal in California since 1996, but the courts have given precedence to federal law. The Obama administration has announced it will not prosecute medicinal marijuana cases as long as state law is followed.

In addition, dispensaries are not required to get a special license to sell medicinal marijuana, nor must they identify themselves as anything other than a retail business. In the eyes of the bureaucracy, a medicinal marijuana dispensary is essentially equivalent to a shoe store.

The ballot measures approved on Nov. 2—such as San Jose’s Measure U, allowing for a tax of up to 10 percent—appear to change all that. To pay a municipal tax on marijuana, dispensaries would, it seems, have to declare that they are selling cannabis, which could force a showdown between state and federal law.

Wayne Johnson, strategist for the No on Prop. 19 campaign, argued that Measure U and the other taxes may be unconstitutional because they’d result in self-incrimination. “You’re saying that ‘I’m a purveyor of a controlled substance, I’m paying a tax on it, and here’s a signed statement of how much I sold,’” Johnson said. “That’s an open-and-shut case.”

Johnson cited U.S. v. Leary, a 1969 case in which the Supreme Court ruled that the 1937 Marijuana Tax Act was unconstitutional—since marijuana was illegal in every state, paying a federal tax on pot amounted to self-incrimination, a violation of the Fifth Amendment. (Congress mostly enacted today’s federal drug laws in the Controlled Substances Act of 1970, which lawmakers passed after the Leary case.)

At a San Jose City Council meeting on June 22, Oakland attorney James Silva threatened to “file an injunction against the city” on Fifth Amendment grounds if San Jose implemented a marijuana tax, according to a transcript of the meeting.

Protesters rally in favor of Prop. 19. Voters defeated the initiative but passed several local taxes on cannabis. (Photo: Kelsey Williams)

San Jose Council Member Pierluigi Oliverio, a proponent of Measure U, noted that the tax technically applies to gross receipts of marijuana businesses—the total amount of money they take in—rather than to the marijuana itself. This is analogous to taxing smoke shops rather than cigarettes themselves.

Oliverio declined to comment further on the issue but noted that the city council would discuss how to implement the new tax at a session on Dec. 13. The council also plans to consider implementing a mandatory registration system for dispensaries, Oliverio said.

The tax is scheduled to take effect in March 2011.

The central issue goes beyond San Jose. Throughout the state, dispensaries that sell medicinal marijuana must pay sales taxes to the California Board of Equalization (BOE), just like any other retail business. The same self-incrimination problem may apply there, as well, but the BOE has attempted to avoid the issue by not requiring dispensaries to indicate what they are selling.

According to BOE spokesperson Anita Gore, representatives of the California medicinal marijuana industry approached the BOE in October 2005 to request that they be allowed to pay sales taxes. At the time, the BOE would not issue them seller’s permits—a mandatory license for retail businesses which allows them to remit sales taxes to the state—because the permits require businesses to “obey all federal and state laws that regulate or control your business.”

To help medicinal marijuana dispensaries navigate this quagmire, the BOE decided in a meeting on Oct. 25, 2005, that “it didn’t matter what was being sold,” Gore said. “Medical marijuana dispensaries would be required to register with us for purposes of paying sales tax.”

The registration form, she said, does not require businesses to declare what they sell. “Many [dispensaries] are registered under other things like general merchandise, pharmaceuticals, health food stores, any number of categories they could fall into,” she said.

Dispensary owners who fail to obtain seller’s permits may be fined up to $5,000, charged with a misdemeanor and sentenced to a year in jail, which are the standard punishments for any retail business owners who commit the same violation.

Publicly available minutes from the October 2005 BOE meeting state that the new policy “avoids the issue of self-incrimination” but do not describe the issue any further. Gore declined to comment, saying only that “It’s our job to collect state sales tax.”

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